Ev Ehrlich's Everyday Economics

Hook ‘em, Horns

First, this.  About a month ago, I posed the question, “What are dogs saying when they bark in movies or television programs?” and invited my regular readers (both you and the other guy) to come up with an answer.

One reader did – my daughter and favorite child, Alice.  “It’s easy,” she told me.  “Right behind the actor at whom the dog is barking,” she said, before syntactical remediation, “is a trainer with a piece of steak on a stick.  And the dog is saying ‘Holy shit!  Steak!  Steak!’  And that’s why Eddie (our dog who goes nuts when dogs bark on television) goes nuts – because he hears the dog on television shouting ‘Steak!  Steak!’ and he’s saying ‘Where?  Where?  Where’s the damn steak?’”  Although she didn’t say damn.

Well, you can keep your kids who start their own businesses or go to Harvard or whatever the hell else the Junior Achievers are up to nowadays.  How can you not be proud of a daughter with this kind of native (dare I say it, canine?) common sense. 

A good number of my friends have kids with this kind of strength, and as we age and life becomes a valedictory, it’s a source of ever-growing pleasure.  One of my lifelong best friends’ daughter, for example, just decided to go to the University of Texas (for whom I rooted unsuccessfully against Alabama -- Hook 'em, Horns!) next fall and was invited into its Honors Program, which was a source of much happiness for all of us – until, at least, we read last Sunday’s Washington Post. 

In it, UT economist James K. Galbraith (and therefore putative prospective mentor of the kid in question) argues for getting rid of the Congressional Budget Office, much as he would tell a man with cardiovascular disease to fire his cardiologist – because the news he brings is not to his liking.  And in a world in which the inability of a third-tier tourist-and-remittance economy like Greece to manage its budget takes us to the edge of a global shitstorm, the idea that anybody – let alone the CBO – is “fear mongering” on the deficit needs to be scrutinized carefully.

OK, full disclosure – I worked at CBO from 1977 to 1988 and am proud of the time I served there.  And the place has had a number of smart and honest Directors, people I admire, from all across the political spectrum -- Alice Rivlin, Rudy Penner, Bob Reischauer, Doug Holtz-Eakin.  I wish I could tell you that I’d have written these notes even had I not worked there, but that’s unlikely, as working there gave me an insight into what they do there and why, an insight that appears to have gone unshared with Professor Galbraith.

His piece in the Post reads like this:

 …CBO's projections are indefensible, internally inconsistent and economically impossible. …The CBO predicts that unemployment will fall to near 5 percent by 2014 and stay there. It also expects a rapid recovery in the next few years, followed by a steady 2.4 percent GDP growth rate thereafter. Inflation is expected to stay below 2 percent indefinitely.  But …CBO also projects that short-term interest rates will increase from less than 0.2 percent now to 4 percent in 2014 (and higher later), while rising health-care costs will drive Medicare expenditures ever higher.

Well, let me start there.  In fact, I’m fairly optimistic about where the economy is headed, and I don’t think that’s a bad forecast at all.  The economy has a lot of pent-up demand, credit availability is just getting going again, business are flush with cash, and with burgeoning technological progress and ever-increasing world trade, it’s awfully hard to tell a story about why we’re going to see inflation any time soon.  And even if I didn’t feel that way, at least I’d understand how CBO gets to its forecast – its usual practice is to assume that, regardless of where we start, the economy returns to its long-term trends (the 2.4 percent number that Galbraith derides) and stays there. 

Not good enough for Galbraith:

These things cannot happen together. If the CBO's happy growth scenario is right, with low inflation and low unemployment, why would short-term interest rates rise?

What part of it don’t you get?  Because the country is in hock, son, and as when you borrow a great deal of money, the vig goes up.  Ask Greece.  Besides, if the economy does grow over the next four years, enough to take us back to five percent unemployment, then “real” interest rates – the spread between interest rates and inflation -- are going to take off like a rocket.  That’s because government deficits will still be high, but private investment will have been resuscitated – you can’t have sustained, high growth without it.  With the public and private sectors competing for funds, there’s really no way interest rates couldn’t rise by 4 percent.  If CBO hadn’t pointed out that sustained growth in the face of the deficit is going to lead to higher rates, they’d be a candidate for a urine test.

But Galbraith isn’t done.

Conversely, if the CBO's assumptions about health-care costs and interest rates are correct, how can inflation stay low? Ballooning interest payments and health-care spending would spur the economy to full employment and drive up prices -- but also slow the rise in debt as a proportion of the nation's gross domestic product.

Hmm...higher interest payments and rising health care costs are forms of economic stimulus?  They seem more like paying more for the same thing, which sounds more like a drag on the economy than a spur.  And as to driving up prices, health care costs have increased sizably in recent decades, but they haven’t led to general inflation – our economy has been free of significant inflation for years despite health care.  And Galbraith appears to think that higher interest rates lead to higher growth and inflation, instead of reflecting higher growth and inflation.  having it the other way is like saying that your pain caused your headache. 

Besides, according to the Bureau of Economic Analysis, which adds up Gross Domestic Product, net interest payments by the nation’s nonfinancial corporations totaled $227 billion in 2009; in an economy worth over $1.4 trillion, these could double in the next four years and add no more than 0.4 of a percent per year to inflation under the asolute worst of conditions. 

…That miraculous return to full unemployment and those higher interest rates both come from thin air. More likely, given the passivity of today's banks, high unemployment and low interest rates will linger, unless the government moves on a real jobs program. And that won't happen, because of fear-mongering about the debt -- buttressed by the CBO.

Ah, well now we get down to it.  Galbraith’s concern isn’t that we’re getting the deficit wrong.  It’s that we might be getting it right -- that is, it's big, but needs to be bigger.  His concern is that we haven’t run a larger deficit-spending program than the one the Administration did last year.  And by pointing out what that kind of a program would cost, CBO is an obstacle to his own policy preferences.  And those preferences are revealed in his last remark:

If we'd had a CBO in the 1930s, Franklin Roosevelt could never have gotten the New Deal off the ground.

There are all sorts of reasons to be concerned about that remark.  For one, it’s just not true.  The largest deficit during the Depression was 4.76 percent of GDP in 1936, less than half of today’s, and lower than the deficit was in 1985 and 1986, during the height of the Reagan Boom, when CBO was in full flower.  Second, we’re seeing in Europe what the consequences of too much borrowing – even if for important policy objectives – can be.  So while the human cost of slow growth and unemployment is frighteningly large, another round of deficit spending might create a crisis of its own. 

In fact, the Administration has had it right, Galbraith’s views notwithstanding, just about from Day One.  It had the courage to implement a massive stimulus program last year that probably saved us from unemployment rates at 12 percent or higher.  We are going to have to pay for that program, and the Administration rightly should be judged on how they deal with it.  But if we have the maturity to confront the problem, restoring some fiscal balance is well within our ability.  Moreover, the Administration’s commitment to “financial stability no matter what it took” worked pretty well – the financial system was pulled back from the abyss and the cost of doing so turned out to be far smaller than expected.  It wasn’t pretty, and we’re still waiting for the kinds of financial regulation that restructure the system to prevent a recurrence, but it worked.  And, again, those who characterized their program as insufficient -- some of whom advocated nationalizing the banking system -- were wrong once again.

Galbraith is among the "didn't do enough" group, but he can’t figure out which side of the argument to take.  The risk in the economy isn’t that rates aren’t going to rise – they’ve got nowhere to go but up.  The real risk is that the economy doesn’t grow the way CBO assumes it will, which means that CBO’s forecast isn’t fear-mongering – in fact, it’s unbridled optimism.  If CBO wanted to fear-monger, they could depict a slower economy with smaller tax receipts, more transfer payments, and less wages, capital gains, and corporate profits to tax.  Instead, they’re showing us what happens if the economy returns to trend.

If Galbraith thinks they’re being overly optimistic, then deficits are going to be larger than CBO projects.  So it’s on him to make the case for more stimulus even though our fiscal mess in even worse than he thinks.  But to argue that the deficit is really going to be smaller than CBO says it will, but that the economy is going to be slower at the same time, and for that reason we ought to have a larger deficit right now, is hard to square.  And throwing out CBO with the spring cleaning won’t make it any easier.